After posting his article “Pompeii and Henry Paulson” on RGEMonitor.com, Chris Carroll has indicated to me that the purpose of this article was to “spur Bernanke to try to provide his own views… My suspicion …is that he [Bernanke] thinks buying the toxic assets is a bad idea …. I think Bernanke believed all along that a recapitalization was the only effective thing that could be done, but he could not persuade Paulson of that”.
In response, I wrote to Chris that if he is right this only demonstrates that Bernanke is poor Chairman of the Fed in time of crisis. I agree that Bernanke was probably intimidated by Paulson (who is nicknamed the Hammer ) into supporting a bad idea. [I would go further and indicate that the first Paulson plan — without any controls on the Secretary — was a terrible idea.]
After all the Central Bank is supposed to be INDEPENDENT of political influence from either the executive or legislative branches! So Bernanke should have said to Paulson — “Go fly a kite! Here is what the Fed is going to do immediately.”
Unfortunately Bernanke did not express his independence and as a result we see that the Carroll’s fire has spread from the insolvent villas of Pompeii to the mansion of stock markets globally. The collateral global economic damage has been immense.
In my book entitled JOHN MAYNARD KEYNES [Palgrave/Macmillan “Great Thinkers in Economics Series”, London and New York, 2007] I argue that there are two competing theories of pricing in securities markets — the Efficient Market Theory [EMT] and Keynes’s Liquidity Preference Theory [LPT].
EMT “demonstrates” that there are market fundamentals that determine the price trend of all equity securities and any movements around that fundamental determined price trend is merely “white noise”. Does anyone believe that when the Dow Jones plunges 35 per cent this is merely “white noise”?
Keynes’s LPT, on the other hand, indicates that, in an uncertain [nonergodic stochastic world], there is no fundamentals existing today to determine tomorrow’s market prices. Accordingly to maintain marketorderliness there must be a “market maker” who can keep market movements orderly and with the help of th government provide an environment that produces a psychological balance between the bulls andthe bears.
“A market maker is someone who attempts to create public confidence in the belief that there will always be an orderly resale market. In other words, in a market where a market maker exists holders of the asset can be reasonable confident that they can always execute a fast exit strategy and liquidate their position in the asset easily at a market price that is very close to the last publically recorded price. In essence, the market maker suggests to holders that if buyers do not appear to purchase offeredsecurities at an orderly decline in price, then the market maker will make his/her best efforts to maintain orderliness even if this requires the market maker to buy, for his/her own account, the securities offered for sale. If the market maker can not support his/her assurance with sufficient cash when a cascade of sell orders come onto the market, then the market will fail, and the asset becomes virtually illiquid as trading will be suspended until the market maker can rally enough additional support for the buyers’s side of the market to reinstate orderliness.
In other words, in our world of nonergodic uncertainty, for an orderly liquid resale market to exist, there must be a “market maker” who assures the public that he/she will swim against any rip-tide of sell orders. The market maker must therefore be very wealthy, or at least have access to significant quantities of cash if needed. Nevertheless, any private market maker could exhaust his/her cash reserve in fighting against a cascade of sell orders from holders. Liquidity can be guaranteed under the most harshest of market conditions only if the market maker has easy direct or indirect access to the Central Bank to obtain all the funds necessary to maintain financial market orderliness. Only market makers having such preferred access to the Central Bank can be reasonably certain they always can obtain enough cash to stem any potential disastrous financial market collapse“.
We are now in the “harshest conditions” and Bernanke is still fiddling while Roman mansions burn.